Date: 20010118
Docket: 1999-2401-GST-G
BETWEEN:
HUGH W. ASHTON,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bonner, T.C.J.
[1] The Appellant appeals from an assessment made under s. 323(1) of the Excise Tax Act (the "Act") in respect of the failure of Ashton-Potter Limited (A-P) to remit net tax under part IX of the Act. S. 323(1) reads:
"Where a corporation fails to remit an amount of net tax as required under subsection 228(2) or (2.3), the directors of the corporation at the time the corporation was required to remit the amount are jointly and severally liable, together with the corporation, to pay that amount and any interest thereon or penalties relating thereto."
[2] The Appellant does not suggest that the elements of liability contained in s. 323(1) are not present. Rather he relies on the due diligence defence set out in s. 323(3) of the Act. It reads :
" – A director of a corporation is not liable for a failure under subsection (1) where the director exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances."
Briefly, the Appellant contends that he met the statutory standard of care by making inquiries of Thomas Silverman, A-P's "Chief Financial Operator" regarding the state of GST, and other "director's liabilities". The inquiries were said to have been made as often as two times a week when the Appellant and Silverman met. The Appellant states that, save on one occasion, until March of 1993 Silverman assured him that A-P's GST account was in good order. The Appellant pointed to evidence from sources other than Silverman which he said supported a reasonable belief that A-P was satisfying the requirements of the Act.
[3] In considering whether a director has exercised care, diligence and skill to prevent a failure to remit tax the Courts have fairly consistently given effect to the statutory language by recognizing that failure can be prevented only before it occurs. Thus the first step in any analysis of the applicability of s. 323(3) is the determination of the time of the failures which gave rise to the assessment in issue. Here the assessment relates to A-P's failure to remit tax, interest and penalties for nine reporting periods starting with the period which ended on June 30, 1992 and ending with the period which closed on April 12, 1993 as a consequence of the bankruptcy of A-P. The returns and remittances were due within one month of the end of the reporting periods[1]. Although it is necessary to focus on the prevention of the particular failures which gave rise to the assessment it is relevant to note that A-P's problems with GST remittances started well before June of 1992. A-P's GST account fell into arrears in April of 1991. Defaults in the timely remittance of GST and attempts to remedy those defaults were recurring events in the relationship between A-P and the GST authorities from then to the date of the bankruptcy, April 13, 1993
[4] A-P was founded in the early 1930s. One of the founders was the Appellant's father. The company carried on the business of a printer. Over the years A-P's business grew considerably. One of the company's major clients was Canada Post. A-P printed ordinary and commemorative postage stamps in both sheets and rolls and it packaged stamps for sale in booklets. A-P also printed labels and books for commercial clients. The business was carried on in an 80,000 square foot plant which contained offices and printing facilities. During the relevant period the average number of employees ranged from 200 to 220 persons. In the 1990 to 1993 period the gross annual revenues of A-P were in the order of $20,000,000.
[5] As a result of both education and experience, the Appellant was well qualified to serve as a director of A-P. The Appellant first joined A-P in 1946 after receiving a degree in Engineering from the University of Toronto. He progressed within the hierarchy of the company. In 1960, he became a director of A-P and held that office until the company became bankrupt in April of 1993. The Appellant became President in the late 1960s. In 1981 he retired as President and General Manager and became Chairman of the Board. The Appellant's successor as president was his son, Hugh E. Ashton who thereafter managed and controlled all aspects of A-P's business. Although in theory the Appellant's position as chairman separated him to a certain degree from day-to-day management there is no reason to suppose that any inquiry or suggestion made by the Appellant to his son or to a member of the staff at any level would have been unwelcome or rebuffed.
[6] During the 1991 to 1993 period A-P had a total of four directors. First, there was the Appellant. Second, Hugh E. Ashton served as director throughout the period. Third was Alexander Smith who became director in 1984 and served until September of 1992 when he resigned. Mr. Smith was a senior executive of a paper company. He was an outside director with no investment in A-P. The fourth director, Ralph Walback, joined A-P in February of 1992 following the acquisition by A-P of Walback's company, Westport Press Limited and the merger of A-P and Westport.
[7] The directors do not appear to have exercised their power over A-P in any formal way. The last properly convened and recorded meeting of the directors of A-P was held in February of 1992 to approve the acquisition of Westport. Thereafter informal meetings with two or three persons who were directors took place frequently but on an irregular basis. Walback was not invited to any of these meetings. Save for a few hand-written notes made by the Appellant in 1993 no minutes or notes of what transpired at the meetings were produced at the hearing. The Appellant said that he had made notes in previous years but that the notes were lost in the turmoil of the bankruptcy. Thus a determination of what happened at the informal directors meetings which took place during the 1991 and 1992 periods must rest on the unaided recollection of the witnesses. The Appellant's memory of events during that period was poor particularly when it came to answering questions asked of him on cross-examination.
[8] The 1991 to 1993 period was a time of financial turmoil for A-P. Conditions in the Canadian printing industry were deteriorating under pressure from labour unions and foreign competition. Costs were increased by measures required to keep up with technological change. A-P's sales were declining. Westport Press was acquired to reverse the decline in sales but that move proved unsuccessful.
[9] During the period in question A-P had an accounting department consisting of seven to eight full-time members. Initially, the department was headed by a controller, Wayne Stubbington. The company's auditor from 1987 forward was Thomas Silverman, a chartered accountant who carried on a public practice. Silverman's role changed gradually. His direct involvement in the day-to-day financial operations of A-P increased. In time Stubbington was required to report to Silverman. In September of 1992 Stubbington was fired and Silverman was given the title "Chief Financial Operator". Stubbington and, subsequently, Silverman were in frequent contact with Revenue Canada's GST collections officials from June of 1991 until A-P became bankrupt. Cheques to pay GST were issued, returned NSF and reissued again and again. Revenue collections officials dealt only with Stubbington, Silverman, and Bayne Smith. At no time did Revenue's officials attempt to contact the Appellant regarding the remittance problem.
[10] During the 1991 to 1993 period A-P experienced cash flow problems which resulted in delayed payments to suppliers of raw materials such as ink. According to the witness Bayne Smith, an accounts payable clerk at A-P, anyone who worked there would have been aware that the company was in financial difficulties. Mr. Smith, when asked about GST remittances, indicated that " ... like any other vendor their account would have been in constant arrears". Mr. Smith indicated that he had no direct dealings with any director of A-P.
[11] It is the Appellant's position that he was unaware of problems with GST remittances until March 5, 1993. He testified that during the 1991 to 1993 period he came into the plant about four times a week and that he usually met Silverman once or twice a week. He testified that at some of these informal meetings he asked Silverman about GST, unemployment insurance and other government liabilities. According to the Appellant, Silverman's response was that everything was all right although A-P had been "behind" in one payment in 1991. The Appellant admitted that before Silverman became Chief Financial Operator he would have made similar inquiries of Mr. Stubbington. The Appellant stated that at the March 5, 1993 meeting he received notice that source deductions were in arrears and that he made inquiries with respect to GST. He said that Silverman advised him that the Government's figures were wrong. At that meeting the Appellant asked for a legal opinion regarding liability insurance.
[12] Of the three directors who testified at the hearing of the appeal only Alexander Smith was an impressive witness. Smith visited A-P's plant frequently and when there discussed the state of the business with the Appellant. It was on the occasion of such meetings that questions were put to Silverman. Smith indicated that he did not at any time discuss GST with Silverman. Smith said that he did conclude meetings by asking if there was any concern regarding "directors accounts", a term which he said was understood by all to refer to amounts payable under statutes having provisions similar to s. 323 of the Act. I am inclined to believe that the inquiries which the Appellant is said to have made of Silverman were of the same nature, that is to say, they were inquiries about personal liability and not about compliance with the Act.
[13] I am not convinced that either Stubbington or Silverman reassured the Appellant at any time that GST was being remitted when due. The Appellant's version of events was not supported by the evidence of either Stubbington or Silverman. Counsel for the Appellant suggested that Silverman deliberately concealed the GST delinquencies in order to protect his position as A-P's auditor. I reject that argument as unfounded speculation. Even if Silverman was not forthright with the Appellant there is no reason to suppose that Stubbington would have lied to the Appellant regarding GST and it must be remembered that the GST problems started long before Stubbington was fired.
[14] Alexander Smith testified that he was not prepared to rely on the assurances given by Silverman in answer to Smith's questions about "directors accounts". He stated that he simply did not trust Silverman. Concerns regarding personal liability led Smith to resign as director on August 4, 1992. Smith was a close friend of the Appellant. He discussed his concerns about how the company was going with the Appellant.
[15] In February of 1992 KPMG Peat Marwick Thorne submitted a report which had been commissioned by A-P's bank. The bank noted that it had received inconsistent and tardy financial reports. It therefore sought reassurance in the form of an independent opinion on the question whether A-P's inventory was valued in accordance with generally accepted accounting principles (GAAP). Although the answer was that "our limited review procedures indicated that the company's inventory as at December 31st, 1991 was properly valued under GAAP ... ", the fact that the report was sought at all was a reminder of the gravity of A-P's financial problems.
[16] In December of 1992, yet another consultant, Price Waterhouse was retained at the joint request of A-P and its bank to review A-P's operations and current financial position. The report was delivered in January of 1993. The report noted inter alia:
"- During the eleven months ended November 30, 1992, the Company has significantly increased its bank borrowings and level of financing from trade suppliers.
- The company has recently regularly been exceeding its Bank operating loan margins.
- The Company's accounting policies concerning the capitalization of certain costs results in these expenses not being included in calculating net income in the period incurred.
- Management believe that the Company requires additional working capital of a minimum of $3.0 million to finance payment of amounts owed to trade suppliers and reduce bank loans to within levels permitted by the Bank's margin formulas.
- The Company is currently on C.O.D. payment terms with critical trade suppliers.
- It is estimated that the Company is in breach of its loan covenants requiring specific current and debt to equity ratio targets.
- The Company lacks adequate senior financial manager resources. Currently, financial management is being undertaken by the Company's external auditor on a part time basis."
[17] In argument counsel for the Appellant pointed to a portion of the report which indicated that A-P's GST account was overpaid by $73,730 as of November 30, 1992. It will be observed however that the report made it clear that it was based on information received by Price Waterhouse. The probable source was Thomas Silverman. A consultant's report indicating that the company lacked adequate senior financial manager resources cannot reasonably be viewed as supportive of statements made by the incumbent senior financial manager.
[18] A further indication that the financial condition of A-P was questionable came in the form of a letter of August 4, 1992 to A-P from its bank. The letter opened as follows:
"We have recently completed a review of your Banking Facilities on the basis of your December 31, 1991 year-end financial statements and current financial information including forecasts for 1992. The reduced profits being reported coupled with the start-up of Ashton-Potter America Inc., the merger with Westport Press Limited and inventory levels that have increased rather then (sic) reducing in relation to sales has weakened the company's working capital position to a point that gives us cause for concern. While the working capital problem is understandable to a degree and we continue to expect improved operating results the company requires an investment of capital and must find ways to reduce inventory levels to improve liquidity and provide for future growth.
...
In March 1992, it was necessary for us to return cheques presented for payment on your account and in the early part of July, we were again forced to take this action. These occurrences and a continuing tardiness in delivery of financial statement monthly has caused us concern and jeopardizes our ability to assist you."
While it is not clear that the Appellant saw the letter the problems identified by the bank cannot have escaped his attention.
[19] The due diligence defence has been raised in a very large number of cases arising under s. 227.1 of the Income Tax Act and, in a smaller number of cases under s. 323 of the Excise Tax Act. Counsel for the appellant argued that by reason of a difference between the social policy underlying s. 227.1 and what was said to be the less important social policy underlying s. 323, the cases involving the due diligence defence under the Income Tax Act are of little or no assistance under s. 323. I do not accept this argument. The language of the two provisions is virtually identical as is the purpose. That purpose is to induce directors to act with reasonable diligence to ensure that public money in the possession of the corporation is remitted in conformity with statutory requirements. I have no doubt that the legislature intended that the same standard apply under both acts. Nothing in the statutory context suggests otherwise.
[20] In Soper v. R., [1997] 3 C.T.C. 242 the Federal Court of Appeal attempted to rationalize the case law in this area. Robertson, J.A., at page 262 discussed the standard of care under s. 227.1(3) of the Income Tax Act. He said:
"Rather than treating directors as a homogeneous group of professionals whose conduct is governed by a single, unchanging standard, that provision embraces a subjective element which takes into account the personal knowledge and background of the director, as well as his or her corporate circumstances in the form of, inter alia, the company's organization, resources, customs and conduct. Thus, for example, more is expected of individuals with superior qualifications (e.g. experienced business-persons).
The standard of care set out in subsection 227.1(3) of the Act is, therefore, not purely objective. Nor is it purely subjective. It is not enough for a director to say he or she did his or her best, for that is an invocation of the purely subjective standard. Equally clear is that honesty is not enough. However, the standard is not a professional one. Nor is it the negligence law standard that governs these cases. Rather, the Act contains both objective elements – embodied in the reasonable person language – and subjective elements – inherent in individual considerations like "skill" and the idea of "comparable circumstances". Accordingly, the standard can be properly described as "objective subjective"."
[21] At page 263 Robertson, J.A., pointed to a distinction between the positions of inside and outside directors:
"... I am not suggesting that liability is dependent simply upon whether a person is classified as an inside as opposed to an outside director. Rather, that characterization is simply the starting point of my analysis. At the same time, however, it is difficult to deny that inside directors, meaning those involved in the day-to-day management of the company and who influence the conduct of its business affairs, will have the most difficulty in establishing the due diligence defence. For such individuals, it will be a challenge to argue convincingly that, despite their daily role in corporate management, they lacked business acumen to the extent that that factor should overtake the assumption that they did know, or ought to have known, of both remittance requirements and any problem in this regard. In short, inside directors will face a significant hurdle when arguing that the subjective element of the standard of care should predominate over its objective aspect."
[22] When the subjective elements of the standard of care are considered it is evident that the Appellant was almost ideally qualified to prevent the failures which occurred. I refer to his education and to his experience as an employee, executive and director of A-P. Nothing in his personal profile prevented him from obtaining an accurate grasp of what was happening. The Appellant was plainly an individual of the type described by Robertson J.A. as an inside director.
[23] In my view a careful consideration of the rather unimpressive evidence regarding Silverman's assurances supports a conclusion that the questions asked of Silverman were not whether GST remittances were being made as required by statute. That question was never asked, at least in the presence of Alexander Smith. Rather the directors wanted to know whether they were exposed to personal liability. It seems likely to me that such assurances as were given by Silverman were the result of his belief that A-P would eventually ride out the financial storm and satisfy its liabilities. In my view the Appellant was under a positive duty to act to prevent the failures. This is not a case in which a sudden catastrophe led to a failure which could not reasonably have been anticipated and prevented. Rather it is a case in which the Appellant failed to react to an abundance of evidence clearly indicating the existence of a financial crisis. That crisis may have worsened over the relevant period but there is no doubt that it existed throughout. It is striking that the Appellant's inaction continued despite the problems which led A-P's bank to secure two separate reports from financial consultants. The crisis was of such severity that, if the Appellant did not know that GST was not being remitted, it was because he did not address the question. In either case the Appellant was in breach of the statutory standard of care.
[24] In Ann Drover v. The Queen, 98 DTC 6378, Robertson, J.A. described the circumstances in which a director may be under a duty to take positive steps to prevent a failure. He stated at p. 6380:
"The "objective" subjective" standard of care outlined above focuses on whether the surrounding circumstances are such that a person of the director's ability and business experience was under a positive duty to act as to ensure that the corporation's obligation to remit withholding taxes was fulfilled. Certainly, such a duty exists if a director is aware or should have been aware of a remittance problem, and is breached if no steps are taken to ensure compliance with the legislation." (emphasis added)
[25] The appeal will be dismissed with costs.
Signed at Ottawa, Canada, this 22nd day of January 2001.
"M.J. Bonner"
J.T.C.C.